MBS UPDATE: Stop the Bleeding
W out Barack in. Today begins a new period of policy and rejuvenated prospects for progress. President Bush leaves a tall task for the newly sworn in 44th President though. Barack Obama is confronted with a feeble economy supported by government spending (US debt load is now $10,628,881,485,510.23), the withdrawal of American troops from an estimated $2 trillion war, amending Reagan-esque tax cuts, reforming the world's most expensive health care system, regulating contracting capital markets, creating demand for labor, jump starting Real Estate ...etc etc etc. Inheriting a $16 trillion economy in the midst of one of the world's worst, if not the worst, economic crisis' ever will not be a straightforward mission. But it is what it is...tomorrow is day 1 President Obama....we wish you nothing but the best of luck!
Initially the biggest challenge for President Obama will be to restore confidence and moderate protectionist trading tactics. The barely functioning US banking system needs to get its rusted out wheels moving. Unfortunately the recent run on Citi and BoA isn't helping but it appears President Obama and his team of advisers are quite cognizant of the issues at hand...and it doesn't seem like they will wait too long to mount an attack.
The policies of the past won't be hastily halted, the largest public spending program since World War II is a necessity at this point. We have already heard of the much publicized plans for another Stimulus package. President Obama is quite confident this direct capital injection will assist in alleviating fiscal stress on Main Street. Express Re-liquefaction of consumer balance sheets is step 1 though. The Quantitative Easing efforts of the Federal Reserve have given our leaders enough time to properly explore strategies to address the core problem at hand: Loss of Real Wealth via asset deflation. Remember the original intentions of TARP? The government was planning to purchase toxic debt from banks in an effort to restore reserves in the banking system which would HOPEFULLY encourage the creation of money. Well those intentions are indeed rematerializing themselves on Capitol Hill...and we're glad to hear it! Until a market is made for stagnant loan portfolios the US economy will be stuck in a downward spiral of job losses and diminishing aggregate demand. President Obama,we in the MBS market are excited for the prospects of a program that would repackage the toxic debt into marketable securities. Although the initial impact would not result in immediate tightening of primary/secondary mortgage rates we feel it will be nothing but POSITIVE...and not just for the MBS market...for all markets. And I don't want to hear anymore hoopla about the US Government defaulting on their debt either...we are the most powerful country in the world...fiscally and militarily (yeah its like that....we're bad...Barack's wallet actually says Bad Mofo). Time to stop the bleeding....
On to MBS...
Fn 4.0-> +0-01 to 100-03+ Gn 4.0-> +0-02 at 100-00+
Fn 4.5-> -0-04 to 101-13+ Gn 4.5-> -0-03 to 101-19+
Fn 5.0-> -0-03 to 102-14 Gn 5.0-> -0-04+ to 102-22+
Fn 5.5-> -0-06 to 102-31 Gn 5.5-> -0-05 to 103-04+
Fn 6.0-> -0-01 to 103-17 Gn 6.0-> -0-02 to 103-15
While the world watched inauguration events the MBS stack remained trapped by uncertainties. High dollar prices of MBS (bids running up into the 104 handle) make fuller coupon purchases a dangerous deal. When MBS coupons are purchased at a premium (over par) the buyer must anticipate that they will recover the initial outlay of purchase funds before the portfolio is subjected to mass prepayments. Essentially you are betting that borrowers are not going to flock to refinance as fast as forecasted. So right now with the entire stack trading over par the accurate estimation of prepayment rates is the key to MBS success. Now that is MBS...not lenders. I REALLY don't need to go into the many many reasons for gapped out primary/secondary spreads again. I will however say that borrowers/mortgage professionals are not the only ones with a stick up their rear about crappy primary rates. Since November MBS investors have held a relatively consistent "down in coupon" rally in anticipation of a government funded REFI BOOM (that would spur on widespread portfolio prepayments). And yet they get nothing in return. So now we wait for direction...capital markets are demanding the delivery of thinner coupons. Until lender's begin to "reduce their reserves" the MBS market will remain stuck. This translates into a tight trading range with short "down in coupon" rallies followed by brief "up in coupon" relative value bids. Oh and don't forget the Federal Reserve, GSE window, and the Treasury remain a source of stability for the MBS market.
But wait...what about the lenders???
Although we have provided accurate estimations of originator hedges, we cant tell you how mortgage bankers plan to price their pipelines each morning. All we can do is continue to analyze the MBS market and provide strategies used to protect your pipeline profits from tape bombs.
Never Float your entire pipeline...instead spread risk out over multiple loans. Take some profits when available to provide a safety net in the event of the unexpected. Remember: your income is more sensitive to market movements when your pipeline is filled with higher balance loans.
Don't get too gluttonous with your margins. Keep track of market gains and set a "stop loss" on floating loans. If you make an additional 25 bps on one loan then set an "exit point" on a floating loan that is 25 bps below your expected price. If prices get worse then it is a zero sum game. Remember: 25bps on a $100,000 does not equal 25 bps on a $300,000. Always make dollar comparisons when deciding what loans to float and what loans to lock.
Each of you has much different break even income levels. Don't lose track of what you need to make in order to cover your obligations. We have heard some frustrated comments about the current primary interest rate environment. We understand..but again all we can do is provide you the tools necessary to make your own decisions. Although we have discussed these strategies in the past, with the recent addition of new readers it is time to elaborate further on the subject. So expect a blog post dedicated to the topic in the near future.